The Appeal of Short Duration Investments

As a fund manager I find myself speaking to investors nearly daily. This gives me a unique insight into the thought patterns of investors, what they value, what they fear, and their predilections. Not surprisingly, investors get very excited very easily, and often end up chasing yesterday’s best ideas today. After a few day or few week stock market rally they feel the urge to jump into stocks with both feet, seemingly believing that the run heralds a new reality rather than interpreting the upward movement in valuation as one that has largely already occurred. Similarly, after a few day or a few week downturn they want to head for the exits, seemingly interpreting the movement as being the beginning of a new bear market rather than viewing the lower valuations as a buying opportunity. What I find most interesting is the gambler-like reaction to such movements – up or down – rather than one that is inquisitive and challenges the rationale for the move to see if there is actually any sensible foundation to support it.

In the time leading up to November 8th, any time it appeared that Donald Trump’s prospects of achieving the Presidency improved the stock market tumbled. The most extreme of these movements was the 800-point decline in futures the evening of the 8th when it appeared that he had won. Then, since November 9th, the market concluded that its fears were not only unwarranted but 180 degrees wrong. The roaring bull market in stocks since November 8th and a concurrent downturn in bonds seems to be based upon a belief that the economy during a Trump Presidency will be buoyant and that the earnings of corporations will soar – a view that is the exact opposite of what must have been in investors’ minds on the eve of the 8th and for the weeks before.

Will corporate earnings indeed soar? If so, will it happen quickly? Is it even reasonable to assume that the “Trump effect” will impact companies’ earnings anytime soon? Is it possible that things could go wrong? The Trump tax law changes, which present companies and their shareholders with the most obvious benefit, may run into some opposition that could delay its approval or even worse. The Trump agenda on international trade could have unpredictable effects, especially in the short run as currencies and foreign governments and competitors react to new challenges. Perhaps it’s worth remembering that the global level of indebtedness, which hangs like millstone around the neck of all economies, remains at historic highs. Now, I’m not saying I’m a naysayer on the Trump economic agenda, only that we live in a world of great uncertainty, and that the bum rush into stocks and out of bonds since the election might be a tad to optimistic given this uncertainty.

In the face of uncertainty, investors ought to prize investments with short duration. Short duration investments act as insurance, protecting investors against the vagaries of uncertainty and its cousin volatility. Short duration investments do not lose much, if any value in the events interest rates head higher, and short duration investments return investors’ principal in the short run, thus allowing them to preserve the important option of investing in opportunities that may not exist now but might present themselves in the future were things to change. This last benefit is of increasing value as uncertainty increases.

The conundrum for most investors considering short duration investments is the ultra-low yield that is generally available with them. This low yield, near zero today for most, is reflective of the valuable embedded option that was described in the preceding paragraph. It is particularly attractive when one can identify short duration investments that also provide a worthwhile yield.

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